The Trump administration has imposed a 25% tariff on steel and aluminum, 10% tariff on imports from China, and plans to impose an additional 10% in tariffs on China and potential 25% tariffs on Mexico and Canada during the first week of March. Additionally, the administration is reviewing tariffs on other trading partners in Asia and Europe.

The stated goals of these Trump administration tariffs on many of its major trading partners include controlling illegal immigration, stopping the flow of fentanyl, stopping unfair trade practices, and bringing home manufacturing and jobs. At least in the case of manufacturing and jobs, there are data that show that the imposition of trade tariffs during Trump’s first presidency coincided with declining U.S. factory orders as well as manufacturing jobs. Since such declines in real economic activity have been experienced when tariffs have been imposed in the United States and elsewhere throughout the past two centuries, similar economic contractions can be expected this time around as well.

How effective tariffs might be in controlling illegal immigration and the flow of fentanyl is considered dubious at best. Most fentanyl smuggled into the U.S. is brought in by U.S. citizens, arrests indicate. Furthermore, tariffs most likely would be ineffective with regards to these two stated objectives since the inflow of these people and goods lie outside the legal systems in the countries Trump is targeting.

Trump is also aware that the trade tariffs that he is imposing will come with negative economic consequences within the United States but is still pushing forward with them, with the hope that fulfilling his campaign promises will politically outweigh the economic pains U.S. consumers are likely to face. This is a very big gamble that seems unlikely to succeed, given evidence culled from past tariff and trade wars. Furthermore, the promise of reducing inflation was one of the most important factors that helped Trump win the 2024 election. Tariffs will be inflationary.

The tariffs may help U.S. manufacturers of steel and aluminum but are raising costs for users of these products. The net impact of these tariffs could be negative for the U.S. economy by way of raising costs to consumers who account for 70% of U.S. gross domestic product.

While the rate of inflation growth has come down in previous months, the cost of goods and services today are significantly higher than they were prior to covid. This has been a major pain point for U.S. consumers. A revival in inflation due to higher tariffs could precipitate an economic slowdown.

A combination of tariffs and higher borrowing costs could weigh on consumption and act as a headwind to economic growth. Tariffs also will reduce overall economic activity and will divert private sector money to government tariff payments that otherwise might have been put to productive economic investments in business equipment, inventories, and hiring more employees.

The negative consequences for overall economic growth due to the imposition of tariffs will combine with the negative effects on economic activity of other early Trump initiatives. Slashing government employment reduces taxes paid by government employees and increases unemployment insurance payments by the government. A one trillion-dollar reduction in U.S. government spending could reduce total U.S. real economic activity by 4% – 5%, a deep recessionary consequence. Adding to that the cancellation of various government infrastructure and other programs, the contractionary forces on the total U.S., and global, economies would be significant.

Tariffs and some other programs clearly would increase inflation and reduce real economic growth. The effects on fiscal policies and monetary policies are less clear.

Early indications are that these policies would increase the size of the federal deficit for several years, due to reduced tax receipts, higher unemployment insurance payouts, and other factors. The nonpartisan Congressional Budget Office has estimated that the proposed Trump policies could increase annual federal deficits by more than one trillion dollars per year over the next four years, boosting the federal debt outstanding by a similarly sized accelerated amount. 

The Fed’s options also are likely to be limited if an economic downturn is accompanied by strong inflation.

The Fed at its most recent meeting said that it was in no rush to lower interest rates. Its last projections for interest rates, released in December, suggested a 50-basis point (bps) reduction in the federal fund interest rates for 2025. Its next projections will be released in March, and the jury is out on what those projections could look like. Some market participants are expecting the Fed to continue projecting a 50-bps reduction, while others are expecting a decrease in the number of reductions or even no reductions.